S&P 500 Yields Match US Bonds as Wall Street Bets on Earnings

The S&P 500 index is currently offering an expected annual return of approximately 5.3 cents per dollar invested, a figure nearly identical to the yield on 10-year US Treasury bonds, which closed at 5.28% on Friday. This marks a significant shift from much of the last decade, when stocks consistently offered a higher return than bonds. The S&P 500's forward price-to-earnings ratio, which reflects the expected earnings of companies over the next 12 months, stands at around 19, translating to an earnings yield of about 5.3%. This convergence means investors in stocks are no longer receiving a substantial premium for the added risk compared to the perceived safety of US government bonds.

Despite this, the Nasdaq 100 reached an all-time high on Friday, surpassing 30,800 points and showing a year-to-date increase of approximately 22%. The S&P 500 closed the week just below its August peak. Leading the recent market gains, particularly in the last quarter, have been major AI companies like Microsoft, Nvidia, and Apple, with Nvidia hitting a new intraday high. Analysts anticipate a significant surge in earnings for S&P 500 companies in the third quarter, projecting a 30% year-over-year increase, which would be the third consecutive quarter of over 25% profit growth. Revenue growth is expected to be around 12%, exceeding the recent five-year average. Technology companies are forecast to see a 65% jump in profits, with chip manufacturers potentially more than doubling their earnings, while the energy sector also benefits from Brent crude prices above $100 per barrel.

The forward P/E ratio for the S&P 500 has decreased from over 20 at the end of June to around 19, even as the index approaches its record high. This suggests that stock prices have not become more expensive relative to earnings; rather, the cost of capital, reflected in bond yields, has increased. More than 70 companies in the index have issued positive earnings guidance for the upcoming quarter, the highest number since 2006, with nearly half being tech firms. Conversely, the number of companies lowering their forecasts is at its lowest since 2021.

Thirty-year Treasury yields also neared 5.7% last week, levels not seen in over two decades. This rise in yields negatively impacts companies that finance operations, such as data centers, through debt. The iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) has lost about 7.5% year-to-date as bond prices fall with rising yields.

Many Israeli savers who invest in S&P 500 index funds through provident funds and study funds are also affected by this trend. Institutional investors might shift funds from stocks to bonds if upcoming earnings reports disappoint, given the similar returns with lower risk from US Treasuries. Alternatively, if earnings meet expectations, the declining P/E ratio could make stocks appear even more attractive without price drops. Friday's weaker-than-expected jobs report offered some relief regarding further Federal Reserve interest rate hikes this month, though yields remain near their peaks. This week's focus includes the Fed meeting minutes and the start of the earnings season, with JPMorgan scheduled to unofficially kick it off.